Business for Engineers: Offshore Outsourcing

Outsourcing in general requires a more complex corporate structure to manage a geographically dispersed and legally separate organization.

"To be, or not to be, that is the question." This may be the opening line of a famous soliloquy in Shakespeare's Hamlet, but it could easily be rewritten for modern business as "To outsource, or not outsource, that is the question." And the final outcome could mimic Hamlet's death.

The simplistic view is that management will choose the lowest-cost method of achieving the goal. This has given rise to the job flight that's seen by many industrialized countries. But how a specific company (yours) will prosper in the long haul needs to be considered more carefully.

In the second half of the 20th century, a vocal group of economists began promoting an absolute measure of economic efficiency irrespective of the long-term implications. The theory is that, by generating more cash for shareholders, companies will improve the general economy, along with their own financial health. But the short-term nature of US business measures fed a natural tendency among those steeped in the financial side of business to ruthlessly and blindly cut costs. After all, their job was to maximize shareholder value, wasn't it? The financial benefits of cutting costs drop directly to the bottom line and result in stronger earnings reports. This drives corporate valuation higher, which is reflected in higher stock prices. As a nice bonus, executive bonuses go up, because they are usually tied to financial performance.

Let's look at the premise of maximizing shareholder value. The first question to ask is "Value over what period of time?" Clearly, if value is to be measured only over the next 30 days, the answer is simple: Fire everyone except the people who fulfill orders and collect payment. Operating costs plummet, and sales continue for the next 30 days. But what happens in the following 30 days -- and the 30 days after that? You don't need a big degree to intuit that the business will die as promotional effects dry up, product development halts, and the word gets around that the company has effectively shut its doors.

Many companies have outsourced to a lower-cost country in their bid to bolster earnings. Executives strive to create strong near-term value while preserving product development. Some companies have shipped all development to foreign countries, while others have taken partial steps in this direction.

Some advocate shipping all research and development (R&D) to countries like China, because they are building up capacity and capability to achieve R&D at a lower cost. Could there be a middle ground for outsourcing? Outsourcing in general requires a more complex corporate structure to manage the geographically dispersed and legally separate organization. In a 2013 paper on offshoring, a team of German researchers write:

Our findings hence imply a trade-off between global knowledge sourcing and a firm's ability to use this knowledge effectively. The empirical results suggest that off-shoring more than 15 to 30% (depending on the type of innovation) of a firm's innovation activities becomes challenging for maintaining the effectiveness of the organization.

Innovation activities more closely related to the company's core functions (R&D and marketing of innovation) are more sensitive to outsourcing, regardless of the source. If a substantial part of these activities take place in foreign countries, hidden coordination costs increase, and organizations become more complex.

The researchers give some startlingly simple advice in the conclusion: "Keeping most R&D activities at the home base is beneficial in a world where innovation cycles become shorter and developing new technologies more challenging."

Outsourcing, regardless of how much is outsourced, has some unintended consequences. For example, outsourcing some engineering jobs to offshore contractors depressed job availability for US engineers from the early 1990s until recently. As a consequence, there is a dearth of engineers with 10-20 years of experience in embedded systems development. Some would say that you have to expand the gap significantly between the humps of the bimodal distribution. In recent hiring, I've seen applicants with fewer than 10 years of experience and even more with more than 30 years.

These experience gaps can be largely attributed to the overly aggressive outsourcing of the past. Corporate management in all countries must become more global in their strategy while maintaining local workforce viability. Missteps in managing workforce globalization put both a company and its employees on the wrong end of the power curve. For individual employees, being caught in the middle of poorly planned and executed outsourcing can spell disaster for their chosen profession and drive them to shift to a more viable discipline.

Last but not least, in my previous column, I posed the following trivia question: "What was produced when sewing machines were first set up in a French factory in 1841?" The answer is French army uniforms. As a result, tailors rioted. They feared the machines would put them out of work, and they took their revenge by destroying the machines.

Here's another trivia question for you: What was Henry Ford's first mass-produced car?

@MeasurementBlues You're right that folks get all worked up contemplating off-shoring manufacturing, with visions of dollars signs dancing in their heads.

But the promise often falls short in practice.

Successully managing a multi-continent inter-related organization is not a simple task. Moving to lower cost labor markets carries with it some substantial risk. Some of these markets suffer from institutionalized graft and forgery of basic materials documents. At the very least, the environment requires heightened security and quality control.

But as technology marches forward, the cost of labor becomes a decreasing portion of manufacturing costs. The real advantage that some off-shore facties enjoy comes from lower capital costs and strategic government credits or forgiveness of taxes. In a study that I did a dozen years ago, the major difference in off-shore manufacturing vs US-based factories boiled down to cost of capital. Raw materials costs were essentially the same regardless of location.

Historic decisions to move some capabilities to low wage countries (like semiconductor packaging) led to a dominance by off-shore companies. These previously "low margin" activities have become startegic over time. Thus, US semiconductor companies "gave" this piece of technology away.

Decisions made to off-shore regardless of your country of origin are deceptively strategic. Business executives must take a longer view of their industry and their technology.

But once a product is shipping, the move to offshore manufacturing is enticing to those who only understand the quarterly numbers.

"In my experience off-shoring is seldom the answer to cost containment. In most circumsytances, shortening the development cycle yields much better results than simply controlling costs by using the lowest cost supplier."

@MeasurementBlues Wow! As late as employee #10? I've heard the same class of comments for may years as well. At different points in time it was Taiwan, China, Malysia, Philipines, Mexico, and others.

In my experience off-shoring is seldom the answer to cost containment. In most circumsytances, shortening the development cycle yields much better results than simply controlling costs by using the lowest cost supplier.

Consider a development that is spending $150k per month. A decision to avoid a PCB layout verification cost of about $20k cost 3-5 months of added debug AND a board re-spin. That $20k cost savings cost more than $500k. Then, there is the opportunity cost of being late to market.

At the end, I agree that is essential that engineers understand that motivation for execs. A few execs are straight up about their objectives.. Unfortunately too many executives went to B-school without a strong engineering foundation and now have a toolbox filled with easily misused tools.

"When the only tool you have is a hammer, you tend to view every problem as a nail"

One key enabler of technoloy progree is the close connection between research and manufacturing/production. Invaluable knowledge and training is gained by debugging production issues and refining technology developed in R&D. Once manufacturing is gone, the training ground is gone, along with all the tribal knowledge transfer and cross pollination between the researchers and the shop floor engineers/techs. As some of the other commentators have said, the long term impact of outsourcing and offshoring has yet to hit.

Sorry, Henry, that was not at all my intention. My point was, instead, that the bean counters have different motivations from engineers that work at the company. We march to the beat of two different drummers.

Even if the top execs habitually sugar-coat their motivations with words to soothe the employees, flowery mission statements and the like, it pays for engineers to know the truth.

Outsourcing is but one manifestation of these different motivations. Ultimately, history may be able to decide, in some cases, which decisions were "bad."

I like the graph. Nice to see some numbers attached to the argument. It matches my personal experience.

The thing that gets missed is the long term effect of outsourcing. Maintenance, updates and other activities sound like good outsourcing candidates. Keep the hard, high value, exciting design work onshore and close to headquarters. My experience is that this fails given some time. The grunt work is a good place to train new people. It also lets the designers and engineers know what should be fixed. Without doing the grunt work, you don't have the tools to actually make a better finished product.

We should also remember that headquarters may not be in the US. The outsourcing can come from and go to anyplace in a flat world.

I would also like to see the differnces in offshoring work, versus letting people work remotely. There are similar problems, of distance, communication, and time zones, but remote work still "works", at least according to some people.

@MeasurementBlues Ironically, the decisions to "on shore" jobs has been made for financial reasons. The cost of poor quality outweighs the original fincnial reason to off shore. But the full impact of the decisions 309-30 years ago to off shore has yet to be felt I'm afraid.